Packaging Corporation of America — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; comparisons are with Q1 2017 unless noted. PCA manufactures corrugated packaging and paper products, primarily in the United States.
Financial results and key metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $1,690.6 million | $1,536.5 million | +10.0% |
| Gross profit | $356.1 million | $338.2 million | +5.3% |
| Income from operations | $212.9 million | $203.4 million | +4.7% |
| Net income | $140.1 million | $117.4 million | +19.4% |
| Diluted EPS | $1.48 | $1.24 | +19.4% |
| Operating cash flow | $202.5 million | $164.1 million | +$38.4 million |
GAAP gross margin was approximately 21.1%, versus 22.0%; operating margin was approximately 12.6%, versus 13.2%; net margin was approximately 8.3%, versus 7.6%. Q1 2018 cost of sales includes a $6.2 million classification shift from SG&A under the newly adopted revenue standard, which affects gross-margin comparability. Management reported net income excluding special items of $146.9 million, or $1.55 per diluted share, compared with $119.6 million, or $1.27, in Q1 2017.
Segments: Packaging sales rose 11.6% to $1,402.9 million; operating income increased to $224.7 million from $192.5 million, reflecting stronger pricing, mix and volume, partly offset by higher operating, outage, freight and depreciation costs. Paper sales rose 3.9% to $269.4 million, but operating income fell to $7.2 million from $27.9 million, including $8.8 million of Wallula restructuring charges. Corporate and Other recorded an operating loss of $19.0 million.
Cash, investment and debt: Cash ended the quarter at $102.4 million, down from $216.9 million at year-end. Investing cash outflow was $107.2 million, including $108.0 million of capital spending; financing outflow was $209.8 million, including repayment of $150.0 million of 6.50% notes due March 2018 and $59.4 million of dividends. Long-term debt was $2,481.2 million net of issuance costs; outstanding notes were fixed-rate, with a weighted average rate of 3.64%. PCA reported $327 million of unused revolving-credit capacity, net of letters of credit. The quarterly dividend was $0.63 per share.
Material changes and unusual items
- Revenue increased primarily on higher Packaging pricing and mix and stronger shipments. Packaging segment sales volume and production benefited from strong demand; Paper volume improved, but Paper pricing and mix declined.
- Tax expense declined to $46.5 million from $61.7 million; the effective tax rate fell to 24.9% from 34.5%, mainly due to U.S. tax reform. PCA had not recorded measurement-period adjustments to its provisional Tax Act estimates and expected to finalize its accounting after completing 2017 tax returns later in 2018.
- Q1 2018 special items included $8.8 million of Wallula restructuring charges and $0.3 million of facility closure costs. PCA plans to discontinue certain paper grades at Wallula and convert its No. 3 machine to a 400,000-ton-per-year virgin kraft linerboard machine. Total conversion cost was estimated at about $150 million.
- PCA acquired Sacramento Container in October 2017 for approximately $274 million, funded from cash on hand. Its results are included in Packaging; the purchase-price allocation remained preliminary.
- Operating cash flow included $17.0 million of DeRidder insurance proceeds received in Q1 2018. Capital spending rose substantially year over year.
Outlook, risks and contingencies
For Q2 2018, management expected continued strong Packaging demand, higher corrugated and containerboard shipments, and continued implementation of announced Packaging price increases. It expected Paper volumes to decline as the Wallula machine conversion began, while implementing Paper price increases. Management anticipated continued chemical and freight inflation and wage pressure, partly offset by lower recycled-fiber costs and improving energy costs; scheduled maintenance costs and the tax rate were expected to be somewhat lower. Overall, management expected Q2 earnings excluding special items to exceed Q1 2018. For full-year 2018, capital investments were forecast at $440–$460 million, including $134 million for the Wallula conversion. Management stated available operating cash, cash on hand, revolving capacity and capital-market access should meet foreseeable needs.
Risks include input-cost and freight inflation, unplanned mill outages, economic and industry conditions, environmental or tax regulation, and execution of acquisitions and the Wallula conversion. Office Depot represented about 7% of consolidated sales and 45% of Paper segment sales in Q1; receivables from it were $75.1 million at March 31, following an extension of credit terms. Litigation related to the February 2017 DeRidder mill explosion, which caused three contractor fatalities and other injuries, remained in early stages; PCA could not estimate a reasonable possible loss range. The company said claims were covered by liability insurance subject to a $1.0 million aggregate deductible. No material guarantee liabilities were identified, and no material changes to previously disclosed risk factors were reported.
Investor verification priorities
- Track whether Packaging pricing and demand offset ongoing operating, freight, outage and labor-cost pressures.
- Monitor Wallula conversion timing, capital spending, restructuring charges and expected reduction in Paper volumes.
- Assess Office Depot concentration, extended payment terms and the recoverability of its receivable balance.
- Review final Tax Act accounting and the sustainability of the lower effective tax rate.
- Follow the DeRidder litigation and investigations, including insurance coverage and any eventual estimate of potential losses.
- Reconcile cash-flow strength with capital spending, dividends and debt service; Q1 operating cash flow included the DeRidder insurance recovery.